The United States Department of Transportation benefits from extremely favourable conditions to push the use of public-private partnerships. Public attention to the country's infrastructure is elevated in the wake of the Minnesota 35W bridge collapse in August 2007. Public distaste for fuel taxes, which fund most US transport infrastructure, has become an election issue. Local and federal budgets have become stretched as the economy worsens.

In its 2008 white paper, "Toward a New Surface Transportation Economic Model", Mary Peters, the US Secretary of Transportation identifies the main problems as "exploding highway congestion, unsustainable revenue mechanisms and spending decisions based on political influence as opposed to merit." Peters' job is to find solutions.

The main alternative to tax-based financing and government borrowing is private investment, and Peters estimates that there is $400 billion available in private sector funding, from which US surface transportation might benefit. Indeed, she has been a proponent of moving towards more diverse sources of funding since she was head of the Federal Highways Administration (FHWA) in 2005.

But this private infrastructure funding has been slow to mobilise, the victim of state-level political battles, public and even business scepticism of PPP, and now turmoil in credit markets. While equity is still assumed to be willing, debt markets are exhibiting much more nervousness about the sums necessary to fund road concessions, which has done little for equity's return rates.

Peters believes that infrastructure equity should be less sensitive to the effects of the crunch since, "most investment comes into infrastructure from pension funds, and they'll accept a lower rate of return over a longer period of indebtedness," adding that, "as infrastructure assets can be in some ways a safe harbour if they are properly structured, they may actually benefit in some cases from the concerns with overall liquidity."

The proposed lease of the Pennsylvania turnpike, for which a $12.8 billion bid has been received from a consortium of Abertis and a Citi-led fund, but for which enabling legislation has yet to pass, is at the forefront of the debate. Before the markets crashed, the state's adviser Morgan Stanley, valued the concession at between $12 billion and $18 billion, and in the current conditions, the borrower will be paying, at around 200bp over Libor, more than twice the margin on the previous comparable deals in Chicago an Indiana.

Tyler Duvall, the under secretary for policy and assistant secretary for transportation policy at US DOT, says, "If the Indiana toll road transaction took place today I think that it's safe to say that the valuations would be a little lower, and that the equity would be substantially higher percentage, but that said, I don't think that the overall interest in the space has diminished at all. In fact, everyone that we talk to says that the ability to raise equity is as strong as it has ever been. It's hard to assess, given these macro credit conditions, which are a huge factor in everybody's equation right now."

The US DOT has two main funding programmes at the disposal of private sector infrastructure developers, as well as various sources of cash for local governments that want to implement new transport funding programmes. Local political struggles have hindered the effectiveness of both, but sponsors and lenders have consistently identified areas where they would like US DOT's incentive package to be more responsive.

US DOT's funding foundation

"In the last Surface Transportation Act [2007] we attempted to create some incentives," says Peters, "Private Activity Bonds allocations, for example, $15 billion of PABs. We also changed the way the eligibility for TIFIA loans is calculated, to make it available for multi-modal projects and intermodal projects, again in an attempt to attract investors from the private sector, and we also created the SEP-15 programme, on a pilot basis, to fast-track decisions."

TIFIA is the acronym for the Transportation Infrastructure and Innovation Act of 1998, but has become shorthand for the 35-year tax-exempt subordinated loans that feature on most greenfield toll road PPPs in the US. The administration has also launched a $1.2 billion Urban Partnerships fund, which Peters calls "a one-time shot", intended to inject some funding into congestion relief in major urban areas.

The most recent DOT-centred legislation was the 2005 Safe Accountable Flexible Efficient Transportation Act: A Legacy for Users (SAFETEA-LU), which was modified in 2007 to accommodate changes in both the financial markets and attempt to iron out some of the kinks of the original legislation. Indeed, one of these changes allowed TIFIA loans to refinance existing project debt, allowing a loan for Transurban's Pocahontas Parkway PPP deal with Virginia Department of Transportation, which closed in 2007.

Most of the funding for programmes such as TIFIA comes from the Highway Trust Fund (HTF), for which fuel tax is the main source of income. Peters states, "The highways account of the HTF is highly likely to go into deficit soon, as early as next fiscal year, and I do not see willingness right now, nor public acceptance to raise gas taxes." But TIFIA will not be among the principal victims of this policy inertia. "I think that traditional sources of funding for surface transportation at both the federal and state level are going to diminish, which will create the demand, in my opinion, for more and more private investment."

TIFIA at ten

TIFIA is probably the most developed and well known of the federal support programmes for private developers. TIFIA loans have been employed on 15 projects nationwide, including a number of large transportation PPPs; the Texas SH130, Pocahontas and the recent Capital Beltway high occupancy toll (HOT) lanes project (for full details on the financings of each of these projects, search them by name).

From a borrower perspective, the characteristics of a TIFIA tranche in a road financing are appealing; slim margins on subordinate debt, with long periods of interest-only payments, of which only 25% is mandatory, with a flexible deferred payment option. However, the benefits are less tangible when considered by bank lenders.

Conor Kelly, managing director of DEPFA Bank's infrastructure group, has experience on both sides of the argument, as financial adviser and lender on a number of TIFIA deals. He notes, "as an adviser, we love it, because the use of TIFIA funding significantly reduces the financing risks on a project through its flexibility. However, he continues, "As a lender, it's less appealing due to the springing lien in the event of a bankruptcy event, which brings the TIFIA loan up to parity with the senior lenders. A couple of the rating agencies do not give sufficient credit to the TIFIA loans structural or cash-flow subordination or low probability of default when providing a project rating and therefore often include the TIFIA debt service requirement in their senior coverage ratios thus limiting the value it adds to a project's capital structure."

TIFIA loans have also raised problems in execution. Another complaint from borrowers and their advisers is that the TIFIA process takes to long, something that Peters recognises as a significant hurdle; "We're working hard to try and make that process more nimble, more responsive, because it does take too long and it has discouraged some from applying for the process because they feel that the length of time it takes to get it through is not helpful."

One way to speed up the process, Peters notes, has already been attempted; the possibility of the awarding authority applying for funding prior to awarding a project, "Some of the Texas projects pre-applied for TIFIA loans and pre-negotiated some term sheets and the adjusted those when they had a successful bidder, which tended to speed up the process." This kind of application, before a project is awarded, is permissible under the experimental SEP-15 waiver.

The Texas projects, however, proved problematic for other reasons. The state-imposed moratorium in Texas in 2007 vetoed the use of private concessions for toll roads for a period of two years, and though the legislation had a number of loopholes, and lasts for only two years, it nonetheless overturned a lease of the State Highway 121, which had already been awarded to a Cintra-led consortium. When the North Texas Transport Authority was re-awarded the project, its eligibility for the pre-approved PAB allocation and TIFIA funding became void.

Duvall suggests that, although the SH121 outcome might have had a limited impact on PPP's public image, the threat of municipal authorities to forthcoming deals is not a sustained one; "Though PPP is competing against municipal borrowers, they are in some ways facing even more severe credit problems. Everybody is trying to raise money on a long-term basis right now, and encountering some problems. I don't think the private sector's problems are any more severe. I think the fiscal situation of the state and local governments is far more serious in the long term than it is for the private sector."

Words and bonds

One Texas project that escaped the moratorium, and competition from the private sector, however, still opted to pass on an offer of PAB funding. The SH130 concession in Texas, also held by a Cintra-led consortium, and not subject to the moratorium, had similar pre-approval for TIFIA and PAB support. Despite the possibility of tax-exempt bond financing, the sponsor opted not to take advantage of the allocation.

At the time of financial close, in April 2008, Cintra's US director, Jose Maria Lopez de Fuentes, explained that having already secured the TIFIA loan, and a strong syndicate of banks, that they did not need the PAB assistance, and that the length of the process may have outweighed the benefits.

Since the project had already suffered delays because of the moratorium, the SH121 fiasco, and the effects of the credit crunch, the sponsor's impatience was understandable. It robbed the US DOT, however, of the chance to debut the PAB structure. Texas was all set to use up the majority of USDOT's PAB allocation, but its limited number of remaining concessions will not stretch the programme's resources.

Duvall believes that although none of the PABs allocated to Texas projects have been used to date, the pre-approval process is a strong one; "The Texas model of doing these pre-approved TIFIA and PABs combined, and then going out to the marketplace, is a very powerful model which a number of other states are looking at."

Pennsylvania, however, passed on pre-applying, and preferred to let the bidders for the potential lease of the Pennsylvania turnpike come up with their own financing strategies. The preferred bidder, the Abertis/Citi Infrastructure Investors, has an allocation of PABs of between $1 billion and $2 billion, according to the sponsor. But the first PAB financing – Capital Beltway – priced and closed as Project Finance went to press.

Peters lauds Capital Beltway, an 80-year concession in Virginia and Washington DC, awarded to Transurban and Fluor, to design, build, finance and maintain a variable-rate tolled dependent on traffic flow and congestion. Under this system, there is the option for drivers of non-high occupancy vehicles (HOV), with fewer than 3 occupants, to use the HOT lanes at a premium toll rate.

Not only does the deal incorporate a $587 million TIFIA loan and a $589 million PAB issue, but also, involves user pricing, which Peters believes is fundamental to the future of PPP in the US. "We see tremendous potential for pricing," says Peters, "and not just in urbanised areas, but eventually, I would like to see the entire system based on a pricing model, so people would pay for the time of day, perhaps the weight of their vehicle, how many people are in the vehicle, whether they are in their own neighbourhood, whether they are on a major commuter corridor, paying for the use of road systems very much like the way we pay for utilities today."

Says Duvall of the HOT lanes; "The Beltway transaction is a big deal, with the PABs a critical piece of it, and I don't think any major P3 transaction is going to move forward without PABs or at least a serious exploration of PABs, in coming years. The money is so much cheaper, we can do approvals in 30 days of application, and we have a national limitation that is $15 billion, and we're probably going to go through it within a year and a half." Peters has expressed keenness to either raise the cap on PABs, or remove it entirely.

The Capital Beltway deal is a subtle way of introducing congestion pricing into the US public consciousness. Because the HOT lane system offers drivers the choice to pay for a faster route to their destination, but does not oblige them to do so, it is regarded as less contentious than straightforward toll roads or congestion charging, such as in London.

DEPFA Bank advised the sponsor on the deal, and is also providing a letter of credit to support the PABs. Kelly notes that "The HOT lanes are probably the most politically palatable of the PPPs in the US, as they add capacity and provide congestion relief, while giving drivers the option to pay for trip time certainty or take their chances in the heavily congested general purpose lanes."

On equity and its origins

Peters believes that the role of the private sector in the future of transportation is a necessity, but also says that awarding authorities need to strike a sensible risk-reward balance in their dealings with the private sector.
"We in the US have been very risk adverse, unlike other places around the world. We want the private sector to take on all the risk! But that doesn't necessarily make for a successful deal," she concedes. "There are some risks that the public sector, in my opinion at least, is better off taking. Environmental reviews, for example, would be a roll of the dice for the private sector. The other is acquisition of rights of way."

The way in which projects are chosen for financing is also a consideration, and Peters notes that, "In the US today, [financings for projects] are allocated based on political whims and programmatic responsibilities, and a whole host of things but are not performance-related and not cost benefit-related. Whereas, private sector funding will drive to the most cost-beneficial project."

Duvall is more candid, "The discipline of project selection, I think, and project evaluation is so much greater when you raise money through private investment sources because the traffic and revenue estimates have to be right or else people lose money, and so there is just a huge amount of scrutiny in advance of these projects that simply does not exist when the financing is done through traditional mechanisms." Both Duvall and Peters are cognisant that as public sector officials, they do not yet have the experience of the private sector is assessing the risks from an investment perspective.

Kenneth Mead is special counsel for government relations at Baker Botts law firm in Washington DC, and formerly held the position of inspector general at USDOT, during the Clinton administration. He rather more concisely refers to the public benefits of PPP as "The discipline of debt and equity".

When this debt and equity comes from foreign investors, however, more problems have emerged. Peters defers to past experience on international investment in US assets, "I think Mayor Daley [of Chicago] said it pretty well, they're not going to pick up the Chicago Skyway and take it back to Australia or Spain! It's too big and you couldn't get it through airport security! And as Governor Daniels [of Indiana] said, nobody ever complained when Honda and Toyota came in and agreed to build factories in Indiana, predicated on the fact that they were going to have substantially improved transportation infrastructure, but yet if and Australian and Spanish firm want to invest in the Indiana toll road, people are worried about that. I don't see why they would be any more worried about that than about a plant building Toyotas and Hondas."

Mead, however, points out that the public does not just object to the presence of these investors in the US, but more their benefiting from the revenues from these assets. "The American public does not want to see the dollars that it throws into the toll baskets ending up in Australia."

In the case of the Pennsylvania turnpike deal, Governor Rendell, with not a little political shrewdness, included a clause in the bidding process that there must be "significant American investment" in the consortium. Tellingly, he has consistently referred to the preferred bidder as "Citi/Abertis", with the emphasis on the US manager, although Abertis, together with its Spanish shareholder La Caixa, holds a 59% stake in the consortium.

Congestion charging outside cities

Another objection to transportation PPP and user charging is that drivers do not want to pay for something that they formerly perceived as being free.

Under the 2007 Urban Partnerships initiative, five cities were allocated a portion of $1.2 billion in funding to implement a congestion relief programme (for full details of the projects, see www.upa.dot.gov). New York City was allocated $354 million to implement a congestion charge plan, the revenues of which would be used to fund mass transit. The New York legislature rejected the plan, however, and the funds have been re-allocated to Los Angeles.

Mead notes that, "The problem with congestion charging, but also its strength, is that is has to be enough to change drivers' behaviour." For example, the current fee to enter central London on weekdays is £8 ($16), which has proved effective at reducing traffic jams and air quality.

If Peters' plan is implemented, it would mean a shift away from fuel taxes as the major revenue stream for surface transportation. The problem, both in her opinion, and in that of many proponents of the pricing system, is that fuel taxes are invisible to users, whereas user-based pricing is a more obvious hit to the pocket. Nonetheless, according to Peters, the fuel tax was the least popular tax in the US in 2007, overtaking property tax for the first time.

Congestion charging is a progressive tax, much like income tax, whereas fuel tax is a regressive, flat-rate tax, whose rate does not increase with use. Reserving the use of uncrowded lanes for the use of paying customers can strike the casual user as unfair. Kirk Van Tine, a partner, also at Baker Botts in DC, also held the position of inspector general at USDOT, in his case under the Bush administrations. Van Tine, however, notes that the HOT lanes system, in particular, benefits lower-income users too, as it siphons traffic from the free lanes to the faster tolled lanes, easing traffic flow on both.

HOT lanes programmes outside city centres might be much easier than urban congestion pricing to implement, though their need is arguably less pressing. Aside from serving as a more progressive levy, they attract private investment more easily and involve the building of new capacity rather than the managing of existing routes. Says Peters of a country-wide pricing network, "It will take some time to migrate to that system, though we think it will take a much shorter time to migrate to that system than some others do, people think it would be as long as 25 years, but we think it is more in the 10-year timeframe."

However, she recognises that the public is not yet on board with her view; "Aside from political will? Public education, I would say is the major challenge. We could show you surveys that show that the public is more and more receptive to pricing and tolling and less receptive to taxes, especially income taxes. It's about educating the public, saying you're already paying now, because people perceive the roadways to be free now. I think we need public education about the cost benefits."

But signs of PPP's traction with the public are scant. In addition to the Texas moratorium, the California house of representatives recently voted against Governor Schwarzenegger's proposed PPP plan, based on the availability-based structures pioneered by Partnerships BC in Canada, and before that in the UK. Sponsors insist that there is a limit to the number of times they can work through such setbacks.

Peters worries that if the resistance to both private investment and to user-based pricing continues, US infrastructure will suffer; "I don't think that the NY legislature failing to pass it on its own will create a problem but I do fear that if we see too many of these projects go down, in Pennsylvania, for example, if that deal doesn't go, then it could dampen the enthusiasm for these projects in America."